Council of Financial Regulators Annual Report – 2002 2. Australia's Financial Regulatory Framework

Summary of Framework

Australia's financial regulatory framework – the main elements of which were introduced on 1 July 1998 in response to the recommendations of the Financial System Inquiry (the Wallis Committee) – consists of three agencies, each with specific functional responsibilities:

  • the Australian Prudential Regulation Authority (APRA), which has responsibility for prudential supervision;
  • the Australian Securities and Investments Commission (ASIC), which has responsibility for market integrity and consumer protection across the financial system; and
  • the Reserve Bank of Australia (RBA), which has responsibility for monetary policy, overall financial system stability and regulation of the payments system.

The Australian Prudential Regulation Authority is an integrated prudential regulator responsible for deposit-taking institutions (banks, building societies and credit unions) as well as friendly societies, life and general insurance and superannuation.[3] APRA is charged with developing prudential policies that balance financial safety and efficiency, competition, contestability and competitive neutrality.

Deposit-taking institutions are regulated by APRA under a single licensing regime and are all covered by the same ‘depositor protection’ provisions of the Banking Act 1959. This legislation gives APRA the power to act in the interests of depositors, including the power to revoke licences, to make prudential standards or issue enforceable directions, to appoint an investigator or statutory manager to an authorised deposit-taking institution (ADI) in difficulty or take control of the institution itself. If the difficulties prove intractable, APRA can apply to the courts to wind-up the ADI.

Under the ‘depositor protection’ provisions of the Banking Act 1959, depositors have first claim to the assets of an ADI in a wind-up. To support depositors' interests, all ADIs are required to hold assets in Australia at least equal to their deposit liabilities in Australia. These arrangements, however, do not confer any form of guarantee of depositors' funds, and depositors have no recourse to APRA or the Government.

As in the case of ADIs, where the financial weakness of a life company, general insurer, friendly society or superannuation fund could have a detrimental effect on the interests of members and policyholders, APRA may intervene in the management of the troubled entity. In the case of superannuation, the Minister for Revenue and Assistant Treasurer can, on public interest grounds, compensate members of a fund for losses due to fraudulent conduct or theft if the public interest requires it. The assistance can be funded either from Consolidated Revenue or by levying other funds within the industry. Again, however, members' and policyholders' entitlements are not guaranteed by either APRA or the Government.

The Australian Securities and Investments Commission administers and enforces a range of legislative provisions relating to financial markets, financial sector intermediaries and financial products, including investments, insurance, superannuation and deposit-taking activities (but not lending). ASIC's aim is to protect markets and consumers from manipulation, deception and unfair practices and, more generally, to promote confident participation in the financial system by investors and consumers. With this in mind, ASIC seeks to promote honesty and fairness in company affairs and securities and futures markets through adequate and timely disclosure of market information. In addition, ASIC:

  • develops policy and guidance about the laws that it administers;
  • licenses and monitors compliance by participants in the financial system; and
  • provides comprehensive and accurate information on companies and corporate activity.

As part of its consumer protection role, ASIC monitors and assesses compliance with the Code of Banking Practice, the Credit Union Code of Practice, the Building Society Code of Practice and the Electronic Funds Transfer Code of Practice and supervises a number of industry-based alternative dispute resolution schemes.

ASIC also implements the provisions of the Financial Services Reform Act 2001 (FSR Act), which introduced a streamlined regulatory regime for market integrity and consumer protection across the financial services industry. These new arrangements came into force on 11 March 2002, with a two-year transition period.

The FSR Act provides for a harmonised licensing, disclosure and conduct framework for financial service providers, and a single statutory regime for financial product disclosure. At the same time, the framework allows for flexible treatment of different financial products where appropriate (eg basic deposit products will be subject to less intensive regulation than more complex investment products).

The multiple routes to licensing of securities and futures exchanges, and of clearing and settlement systems, have been replaced by a single licensing regime for an Australian financial market and for a clearing and settlement facility. Under the new arrangements, licensees have primary responsibility for the operation of markets and of clearing and settlement facilities; ‘the responsible Minister’ has overall responsibility for licensing such entities. ASIC is empowered to advise the Minister on licensing matters and is also required to undertake assessments of the compliance of market and facility licensees with their legislative obligations, and to take enforcement action where necessary.

The Reserve Bank of Australia has responsibility for monetary policy and for overall financial system stability. The RBA has no obligation to protect the interests of bank depositors or other creditors of banks; rather, its task is to deal with threats to financial stability that have the potential to spill over to economic activity and consumer and investor confidence. In the event of such threats, the RBA retains its discretionary role of ‘lender of last resort’ for emergency liquidity support. If it were to provide such support, the RBA's preference would be to make funds available to the market as a whole through its domestic market operations. In certain circumstances, however, the RBA would be prepared to lend directly to a financial institution facing liquidity difficulties. The institution would have to be one supervised by APRA; would have to be solvent; and the failure to make its payments would have to pose a threat to overall financial system stability. APRA's judgement about the fundamental soundness of a financial institution in distress would be critical to any RBA support.

The RBA, under the auspices of its Payments System Board, also has a mandate to promote safety, competition and efficiency in the Australian payments system, and has the backing of strong regulatory powers. If the RBA, for example, assesses there is scope to improve access to, or the efficiency or safety of, a particular payment system, it can ‘designate’ that system as being subject to its regulation. It may then, in the public interest, impose an access regime on that system and/or set standards for efficiency or safety. The Government envisaged that these powers would be exercised within a broad co-regulatory approach, with safeguards for private sector operators. The RBA also remains responsible for conducting Exchange Settlement Accounts for participants in the payments system.

Under the new regulatory arrangements of the FSR Act, the RBA has responsibility for ensuring that clearing and settlement facilities conduct their affairs in a way that is consistent with overall financial system stability. As part of this role, the RBA has the power to set and monitor compliance with financial stability standards for clearing and settlement facilities. ASIC has responsibility for all other matters relating to these facilities, such as those covering corporate governance, market integrity and investor protection, and for enforcing compliance with the RBA's standards if this becomes necessary. The RBA and ASIC signed a Memorandum of Understanding (MOU) in March 2002 that sets out a framework for co-operation between the two agencies in relation to licensed clearing and settlement facilities. The MOU is intended to promote transparency, help prevent unnecessary duplication of effort and minimise the regulatory burden on facilities; it covers information sharing, notification and other arrangements intended to achieve these aims.

The RBA issued draft financial stability standards for clearing and settlement facilities for public comment in November 2002 and released its final standards in May 2003.

Annual Reports and Internet sites of the individual Council members (see page 28) contain further details about their responsibilities and activities.

Developments in the Regulatory Framework

APRA has now completed a significant overhaul of the prudential standards for the general insurance industry. The reforms include significantly increased capital requirements, a strengthening of reinsurance arrangements and promotion of appropriate risk management strategies and processes. The reforms also introduce a stronger ‘fit and proper’ regime for the management of insurers and for their auditors and actuaries.

Most general insurance companies successfully met the requirements of the new regime and were re-authorised. APRA's re-authorisation process involved a rigorous assessment of each general insurer's situation, business practices and plans. As of July 2002, ten general insurers were in run-off (ie they were no longer writing new policies or renewing existing policies) as a result of the re-authorisation process. Another 15 general insurers transferred their liabilities and exited the market; however, most of these exits were a result of existing insurance groups adjusting their corporate structures.

Progress in reforming the regulatory framework for superannuation gained momentum in 2002. An important input was the review undertaken by the Superannuation Working Group, established by the Federal Government, whose Report, Options for Improving the Safety of Superannuation, was released in March 2002 after a process of public consultation. The Group found that the current prudential regime, which had remained largely intact since the Superannuation Industry (Supervision) Act 1993 was introduced, was generally sound, but the Group recommended changes to modernise the regime and enable APRA to undertake preventative action rather than enforcement action after a breach has occurred.

In its response to the Group's recommendations, and to a separate review undertaken by the Productivity Commission, the Government announced in October 2002 that it would introduce a number of reforms to the prudential framework governing superannuation. The principal reform is a universal licensing regime, under which all trustees of APRA-regulated superannuation funds, approved deposit funds and pooled superannuation trusts will be required to be licensed by APRA and to comply with the licensing requirements on an ongoing basis. Trustees will be required to prepare and submit to APRA a risk management strategy for themselves and a risk management plan for each fund or trust they operate.

In order to obtain a licence, trustees will be required to demonstrate that they have the capacity, competency and means to operate a superannuation business. Trustees must, for instance, have adequate resources in place, including financial, technological and human resources, as well as appropriate risk management processes. Trustees will have to meet fit and proper requirements and minimum standards of competency. They must also demonstrate that they have adequate outsourcing arrangements and adequate levels of insurance such as professional indemnity insurance. The new licensing regime leaves unchanged the capital requirements for trustees of public offer entities; no capital requirements will apply to trustees of non-public offer entities.

A draft Bill to amend the Superannuation Industry (Supervision) Act 1993 to give effect to the new licensing and prudential arrangements was released in June 2003. The details of the prudential requirements will be contained in operating standards, which APRA has commenced drafting for industry consultation. The reforms are expected to come into effect from April 2004, with licensing to be undertaken over a two-year period starting on 1 January 2004.

Another important development in strengthening the prudential supervision of superannuation was a revision of the reporting framework for superannuation entities. The revised reporting forms consolidate the reporting requirements of APRA and the Australian Bureau of Statistics (ABS); they also widen the range of prudential data collected and align the reporting requirements more closely to Australian accounting standards. The additional information collected will assist APRA to supervise superannuation funds and trustees more effectively, and to identify funds that may be experiencing problems or that are not being managed in a prudent manner. The revisions to reporting requirements will be given legal effect through Reporting Standards determined under the Financial Sector (Collection of Data) Act 2001. Industry consultation on the requirements has taken place during the first half of 2003, and the new reporting framework will apply largely for financial years ending on or after 30 June 2004.

To enhance its prudential supervision processes and also guide the optimal deployment of its resources, APRA has developed a Probability and Impact Rating System (PAIRS). PAIRS is a consistent risk assessment tool that integrates risk of potential failure and its potential impact into a single measure of overall supervisory concern. PAIRS operates in conjunction with a Supervisory Oversight and Response System (SOARS), under which the PAIRS measure of supervisory concern is translated into an appropriate supervisory stance: ‘normal’, ‘oversight’, ‘mandated improvement’ or ‘restructure’. PAIRS draws on international best practice and builds on and harmonises the approaches of APRA's predecessor bodies. The building blocks for assessing probability of failure are based on the types of risks incurred by financial institutions, and those for assessing potential impact are based on institution size. Quantitative assessments of probability and impact are combined to determine a Supervisory Attention Index while, in parallel, qualitative factors determine Supervisory Stance.

Figure 1

PAIRS was implemented in October 2002. Over the following six months, 15 per cent of entities, covering 78 per cent of financial system assets, were rated at least once. In due course, APRA intends to advise each rated institution of its rating but ratings will not be disclosed publicly.

APRA released revised prudential standards for the supervision of ADI conglomerates in November 2002. The revised standards, effective from 1 July 2003, relate to capital adequacy, large exposures and associations with related entities. On capital adequacy, the main change is the application of requirements to the full conglomerate group incorporating all associated entities, allowing more sophisticated methods to be applied, including the use of internal models. These will only apply to prescribed conglomerate groups where insurance or other non-banking activities form a large part of their activities, justifying a more complex supervisory treatment. The new standards on large exposures and associations with related entities will further reduce concentrations of risk in ADIs' lending and investment activities, both to independent third parties and intra-group. The new intra-group limits will more effectively constrain the potential for risks in an ADI's non-banking subsidiaries to impact on the ADI. Recognising that some ADIs have existing relationships that do not fully comply with these requirements and will take some time to unwind, APRA is agreeing transitional arrangements with individual ADIs to allow these adjustments to be made in an orderly manner.

A further strengthening of Australia's financial architecture is envisaged in the latest of the Government's Corporate Law Economic Reform Program proposals (the CLERP 9 Paper) – Corporate Disclosure: Strengthening the Financial Reporting Framework – that were released for public comment in September 2002. Some of the key proposals in the CLERP 9 Paper are a response to the recommendations of the Ramsay Report, which reviewed the independence and regulation of auditors. However, the CLERP 9 Paper also addresses issues regarding the financial reporting obligations on corporations. While noting that Australian corporate governance regulation and practice are recognised internationally as being of high quality, the CLERP 9 Paper seeks improvement in various areas in light of recent examples of unacceptable corporate behaviour, both in Australia and overseas.

Some of the key proposals in the CLERP 9 Paper aimed at ensuring the effectiveness and quality of the audit process are:

  • expanding the responsibilities of the Financial Reporting Council to include oversight of auditing standard-setting arrangements and auditor independence requirements;
  • amending the Corporations Act 2001 to include provisions relating specifically to auditor independence;
  • the compulsory rotation of audit partners every five years; and
  • a requirement that all companies included in the All Ordinaries share price index (the top 500 listed companies) have an audit committee.

In relation to the independence of analysts, the CLERP 9 Paper recommends that ASIC, following consultations with stakeholders, provide guidance by means of a policy statement on the level and manner of disclosure required under the general duty on financial services licensees to ensure that financial services are provided efficiently, honestly and fairly.

The CLERP 9 Paper also recommends changes to the continuous disclosure framework to enhance the adequate and timely disclosure of information, including increases in monetary penalties and the introduction of new powers for ASIC to issue infringement notices in relation to contraventions of the continuous disclosure requirements. Finally, the CLERP 9 Paper recommends that Australia adopt accounting standards issued by the International Accounting Standards Board (IASB) for reporting entities for accounting periods beginning on or after 1 January 2005.

For its part, ASIC welcomed the initiatives in the CLERP 9 Paper. ASIC set out its views on the proposals in a submission in November 2002.[4]

In 2002, ASIC commenced implementing the most ambitious reforms to financial services regulation. ASIC installed a new electronic licensing system so an expected 7,000 organisations can apply for new Australian financial services licences on-line. ASIC also provided extensive policy and operational guidance to assist the financial services industry in the transition to the new regime.

In releasing the Report of the HIH Royal Commission in April 2003, the Treasurer noted that the Government would be considering the corporate governance and financial reporting recommendations from the Commissioner in preparing the legislation to enact the CLERP 9 proposals.

In August 2002, the RBA announced reforms to credit card schemes in Australia designed to promote greater efficiency, transparency and competition in the Australian payments system. The reforms apply to the credit card schemes operated in Australia by Bankcard, MasterCard and Visa, which were formally ‘designated’ by the Reserve Bank as payment systems subject to its regulation under the Payment Systems (Regulation) Act 1998. The reform measures involve:

  • the adoption of an objective, transparent and cost-based benchmark which will be used as a basis for determining interchange fees in credit card schemes. Interchange fees are the fees paid to financial institutions which issue credit cards by financial institutions which provide services to merchants;
  • the end of the restriction imposed by credit card schemes which prevents merchants from passing through to cardholders the costs of accepting credit cards; and
  • the end of the restriction imposed by credit card schemes which limits the entry of new competitors into the schemes. Specialist credit card institutions authorised and supervised by APRA will be eligible to apply to participate in the credit card schemes.

The first of these reform measures, the ending of the restriction on merchants passing through credit card costs, came into effect on 1 January 2003; the other reform measures come into effect in the second half of 2003. The reforms are currently the subject of legal challenge.

Co-ordination between Council Members

Australia's financial regulatory structure includes mechanisms to ensure effective co-ordination and co-operation between the three regulatory agencies. These mechanisms aim to provide full and timely exchange of information, the avoidance of duplication and a clear delineation of responsibilities, particularly when dealing with matters such as a financial disturbance.

The liaison framework, which is overseen by the Council itself, is a multi-tiered one. The highest level has involved a structure of overlapping Board representation. The legislation has provided for both the RBA (two members) and ASIC (one member) to have representation on the APRA Board and for APRA (one member) to have representation on the Payments System Board. However, the Report of the HIH Royal Commission questioned the participation of RBA and ASIC representatives on the APRA Board from the viewpoint of the governance of APRA and effective co-ordination of activities between the agencies. The Commissioner recommended that APRA's non-executive Board be replaced with an executive group. The Government accepted this recommendation and from 1 July 2003 appointed a full-time executive group comprising three members to exercise APRA's responsibilities. This change will place even greater emphasis on the information exchange and co-ordination functions of the Council.

At the operational level, co-operation arrangements have been set out in three Memoranda of Understanding (MOUs) signed between the RBA and APRA, between APRA and ASIC and, more recently, between the RBA and ASIC. The MOUs cover such matters as information-sharing, prompt notification of any regulatory decisions likely to impact on the other agency's area of responsibility and consultation arrangements in the event of financial disturbances. The first two MOUs also establish bilateral Co-ordination Committees that aim, among other things, to avoid overlaps and gaps in regulatory coverage.

The three MOUs are reproduced in Appendix B.

Council members co-operate on a range of non-routine and routine issues. One important matter has been the implementation of enhanced statistical reporting by Australian financial institutions. These statistics are central to APRA's own responsibilities; they are also important, in aggregate form, to the RBA in pursuit of its monetary policy and financial stability objectives, and to the ABS in the production of economic data. APRA has completed the development of a new computer system (Direct to APRA or D2A) to collect, analyse and store data from regulated entities and, during 2002, it continued the roll-out of new statistical reporting forms. Banks migrated to the new forms during the first half of the year and general insurers followed shortly after. The superannuation industry is expected to commence reporting on the new forms during 2004. APRA, the RBA and the ABS form a tripartite committee to facilitate ongoing co-operation on statistical issues, including any changes to reporting requirements to meet industry and international standards.

Building on a review in 2001, liaison arrangements between ASIC and APRA seek to achieve effective regulatory co-operation and to enhance the linkages between the different organisational structures in each agency. Regular liaison meetings are held every two months, with ad hoc meetings arranged to deal with specific operational matters as and when they arise.

Operational level liaison groups continue to focus on areas of common interest such as enforcement, compliance and disclosure, and jointly regulated entities in the insurance and superannuation sectors. The two agencies aim to share relevant findings of on-site reviews and surveillance where such information could assist the other in carrying out its supervisory functions. The agencies have, through close operational interaction, identified certain compliance deficiencies and have met jointly with industry to address these concerns.

ASIC and APRA are also committed to co-operating in the implementation of the FSR Act, particularly for those entities regulated by both agencies. The agencies have continued to meet to deal with issues arising during the transition period under the Act.

The ASIC/APRA Enforcement Referrals Protocols provide a summary of operational procedures for referral of existing, or anticipated, enforcement matters between APRA and ASIC. These Protocols also provide for regular meetings on general enforcement issues, with case-specific liaison occurring as necessary.


APRA regulates the compliance of superannuation funds with the prudential regulation and retirement income provisions of the Superannuation Industry (Supervision) Act 1993, while ASIC has responsibility for the other provisions. The Australian Taxation Office has responsibility for the regulation of excluded funds (which have less than five members). [3]

ASIC's public submission is available on its website (see page 28). [4]